by Stephen Reed | Accounting News, News, Newsletter, Retirement, Retirement Savings
If you’re considering tapping into your 401(k) for a loan, you should be aware of how these loans function. In this article, we’ll delve into the ins and outs of 401(k) loans, exploring their benefits and potential drawbacks. Whether facing financial hurdles or seeking alternative borrowing options, the information below will help to make informed decisions about leveraging your retirement savings.
The Basics of 401(k) Loans
When you initiate a 401(k) loan, you are essentially borrowing funds temporarily from your 401(k) account. The borrowed amount, along with the interest charged, gets repaid into your account.
The IRS sets guidelines, allowing you to borrow up to 50% of your vested balance or $50,000, whichever is lower. However, if half of your vested balance amounts to less than $10,000, you might be eligible for a loan of up to $10,000.
Keep in mind, though, that while the IRS regulates these loans, it’s ultimately up to your employer to decide whether to permit them.
How a 401(k) Loan Works
Assuming an employer permits such loans, the approval process is typically simple. Unlike securing a loan from a third-party lender, qualification does not depend on a credit check or certain debt-to-income ratio requirements. Depending on how your specific plan handles loans, you will need to reach out to your plan administrator to initiate the loan request or complete an online application.
Once approved, you can expect to receive the funds within two to three business days. Repayment is conveniently handled through automatic deductions from your payroll over a standard five-year period.
Interest rates are determined by your employer, commonly calculated as the prime rate plus 1%. It’s worth noting that the interest paid on the loan goes back into your 401(k) account, effectively allowing you to repay yourself.
Pros and Cons of a 401(k) Loan
When evaluating any type of borrowing, exploring the upsides and downsides is an essential part of the process. On the positive side, these loans offer convenience, with the interest paid funneling back into your account. For instance, if you’re paying 7% interest on a 401(k) loan, that 7% gets reinvested into your 401(k), bolstering your savings. Plus, if you manage to repay a short-term loan promptly or even ahead of schedule, it might not significantly impact your retirement funds.
However, there’s a significant drawback to consider: the risk of losing the tax-sheltered status if you face job loss. Should you take out a loan against your 401(k) and experience a job change or loss before fully repaying the loan, you’ll have a limited amount of time to repay the loan in its entirety. Failing to do so not only subjects the outstanding amount to taxation but also incurs an additional 10% penalty from the IRS if you’re under age 59 ½.
When Does it Make Sense to Borrow from Your 401(k)?
Borrowing from your 401(k) should be a rare incident, but it can be a viable solution when facing a pressing need for significant cash in the short run. However, it’s crucial to reserve this option for substantial needs, rather than trivial expenses.
A 401(k) loan option is typically a better choice than relying on other options such as payday loans or personal loans, which usually carry exorbitant interest rates. Additionally, securing a 401(k) loan is relatively straightforward compared to the complexities of securing loans from traditional financial entities.
When a 401(k) Loan is Not the Best Option
Here are some situations where it’s best to avoid tapping into your 401(k):
- Non-Essential Expenses: Using a 401(k) for luxuries like vacations isn’t advisable as these are discretionary purchases, not necessities.
- Job Uncertainty: If you’re uncertain about your job’s stability or foresee a job change, reconsider a 401(k) loan. Leaving your job without paying the loan could lead to hefty tax obligations.
- High Financial Needs: Given that 401(k) loans are limited to 50% of your vested balance or $50,000, they might not suffice for substantial expenses. Moreover, borrowing a large sum could strain your budget with hefty repayment obligations.
Repayment Rules
Navigating 401(k) loan repayment rules involves adhering to IRS guidelines, while employers oversee specific loan aspects. Here’s what the IRS mandates:
- Repayment Period: Typically, loans must be repaid within five years. The exception to this is when the funds are used to purchase a primary residence.
- Payment Frequency: Minimum payments are required quarterly.
- Job Change Consequences: Upon leaving a job, employees might face immediate repayment demands for any outstanding loan balance. Failure to comply can result in taxable distribution, potentially incurring penalties. To mitigate tax consequences, workers can roll over the balance to an eligible retirement account by the federal tax deadline of the following year.
Alternatives to a 401(k) Loan
A 401(k) loan is likely not the only option available to you. Here are a few other avenues to explore.
Use Your Savings. Tap into your emergency fund or other savings. Ensure your savings are parked in a high-yield account to maximize returns.
Opt for a Personal Loan. Personal loans offer flexible repayment terms without jeopardizing your retirement savings. Many lenders provide quick access to funds, often within a day.
Explore HELOCs. If you own a home with sufficient equity, a Home Equity Line of Credit (HELOC) can be a viable option. Similar to a credit card, it offers revolving credit, allowing you to access funds as needed up to your approval limit.
Consider a Home Equity Loan. With potentially lower interest rates, a home equity loan is secured by your home. It’s an installment loan, ideal for planned expenses. However, defaulting on payments could put your home at risk.
by Jean Miller | Accounting News, News, Newsletter, Retirement, Retirement Savings
At some point in your employment journey, you’re going to find yourself at a crossroads – whether you voluntarily quit a job for a new position or face an unexpected layoff. Amidst the emotional and logistical challenges of these changes, one crucial aspect that requires attention is your 401(k) plan with your former employer. Here’s how to manage your 401(k) plan when employment changes.
Assess Your Options
When you leave your current job, you need to evaluate your available options for your 401(k). Typically, these are your main options:
- Leave it be: In some cases, leaving your 401(k) with your former employer may be a viable option, especially if you’re content with the plan’s performance and fees. This option is often convenient and allows you to maintain the tax-advantaged status of your retirement savings. However, you won’t be able to make additional contributions, and you’ll need to manage the account independently.
- Roll it over into your new employer’s plan: If your new employer offers a 401(k) plan and allows rollovers, transferring your 401(k) to your new employer’s plan would allow you to consolidate your retirement savings, making it easier to manage. Be sure to research the fees and investment options of the new plan before making a decision.
- Roll it over into an Individual Retirement Account (IRA): Transferring your 401(k) funds to an IRA provides more control over your investments and may offer a broader range of investment options compared to employer-sponsored plans. IRAs are not tied to your employer, offering flexibility and portability. Be mindful of fees and investment choices when selecting an IRA provider.
- Cash Out: While it’s possible to cash out your 401(k) when you leave a job, it’s generally not advisable. Cashing out comes with tax consequences, including penalties for early withdrawal if you’re under 59 ½. Additionally, you’ll miss out on the potential long-term growth of your investments.
- Convert it to a Roth IRA: If you’re willing to pay taxes upfront, you can convert your traditional 401(k) into a Roth IRA. You will pay income taxes on the amount converted, but qualified withdrawals in retirement are tax-free. This option may be beneficial if you expect to be in a higher tax bracket in the future.
Understand Tax Implications
When contemplating what to do with your 401(k), it’s important to understand the tax implications that could be triggered. Cashing out, as mentioned, may trigger taxes and penalties. On the other hand, transferring your funds without a direct rollover may result in mandatory withholding. To avoid unexpected tax bills, consider consulting with a financial advisor who can offer guidance based on your personal situation.
Stay Informed About Deadlines
The different options available for your 401(k) are all subject to different deadlines. Missing these key deadlines could limit your choices. Some plans may require you to take action within a certain timeframe, so it’s imperative to stay informed about these deadlines to make the most informed decision possible.
Seek Financial Advice
Navigating the management of a 401(k) plan on top of a job transition can be stressful. A financial advisor will be able to offer valuable insights tailored to your specific circumstances. They can help you weigh the pros and cons of each option and guide you toward a move that aligns with your long-term financial goals.
by Daniel Kittell | Accounting News, Budget, Financial goals, News, Retirement, Retirement Savings
The Federal Reserve reports that 26% of working Americans have no retirement savings. And among the working Americans who have retirement investment funds, 45% feel that their savings projections fall short of their long-term goals. If you’re a late retirement investor, it’s still possible to build a solid nest egg by the time you retire. The tips below will help you make up for lost time and get back on track.
Estimate How Much You’ll Need
A general guideline for retirement savings is to have 10 times your income saved if you plan to retire at age 67. For example, if your annual salary is $50,000 per year, you should aim to have $500,000 saved by the time you turn 67 years old. However, you should adjust this number based on your individual retirement goals. Do you plan to travel extensively in retirement, or do you want to downsize and live frugally? Increase or decrease your estimate based on these goals.
Start Saving
One of the easiest ways to start saving for retirement is through an employer-sponsored plan, such as a 401(k) or 402(b). These plans are even more valuable if your company offers matching contributions. If you don’t have access to an employer-sponsored retirement plan, think about opening a traditional or Roth IRA.
- Traditional IRAs: Contributions are tax-deductible, but withdrawals in retirement are taxed.
- Roth IRAs: Contributions are not tax-deductible, but withdrawals in retirement are tax-free.
Small business owners and self-employed individuals can also look into retirement plans in the form of SEPs and Simple IRAs.
Pay Down Debt
Debt is holding you back financially, so create a plan to pay off credit card debt, car loans, and other high-interest debt. If your mortgage is fairly new, you might also consider making extra mortgage payments in order to pay down some of your principal. However, if you’re in the later stage of a mortgage, and your payments are mainly covering the principal, it might be more beneficial to invest in retirement rather than putting that money toward your mortgage.
Pay Yourself by Automating Investments
Regular, automatic investments can help close your savings gap between now and retirement. While it might seem smart to be sure you’re covering essential expenses with each paycheck before investing, chances are—unless you’re budgeting faithfully—more of your paycheck is going to impulsive and discretionary purchases than you realize. Get ahead of the game by allocating a portion of your paycheck to be automatically and directly deposited to your retirement account.
Start Cutting Costs Now
It is never too early to get organized and prepare for retirement, no matter how close or far off your golden years are. However, if you’re on the closer-to-retirement end of this spectrum, now is the time to start cutting costs in a meaningful way. Start by minimizing expenses and stashing the extra cash away in savings. In addition to cutting debt, find ways to save on everyday bills and costs. These savings can add up and offer some breathing room once you’re no longer receiving a regular paycheck.
Use Catch-Up Contributions
American workers ages 50 and older are qualified to contribute an additional $6,500 in catch-up contributions to their 401(k) per year, increasing the maximum contribution to a 401(k) to $27,000 per year, or $2,250 per month. This is a lofty monthly goal, and might not be possible for many workers, but aim to contribute as much as you possibly can in order to get you that much closer to your retirement goal. Even if you are just beginning to save at 50 years old, by funding your 401(k) up to the maximum amount—assuming an 8.7% annual return and considering compounded interest—it’s still possible to save $1 million by the time you retire.
by Stephen Reed | Accounting News, News, Retirement Savings
The IRS has made some changes for Americans saving for retirement with 401(k) and IRA accounts in 2022. We discuss these changes, as well as what’s staying the same, below.
Changes to 401(K)s
Contribution limits to workplace 401(k)s are going up in 2022. Workers will be able to contribute up to $20,500, which is a $1,000 increase over the contribution limits set in 2020 and 2021. This limit increase also applies to 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. However, the catch-up contribution limit for employees ages 50 and up will not be changing. That limit will remain $6,500.
The contribution limit for a SIMPLE IRA—a retirement plan intended for small businesses with 100 or fewer employees—will increase next year as well. Workers with this plan will be able to invest up to $14,000, up from $13,500. Just as with 401(k)s, though, the catch-up contribution limit for workers at least 50 years old will remain the same. This limit is $3,000.
Changes to IRAs
Unlike 401(k) contribution limits, the limit on annual contributions to an Individual Retirement Account (IRA) is not increasing in 2022. It will remain at $6,000. Likewise, the catch-up contribution limit will remain the same at $1,000. However, income limits for making deductible contributions to a traditional IRA are going up, as are the income limits for making any type of contribution to a Roth IRA.
Income limits for traditional IRAs in 2022 will change as follows:
- For single tax filers covered by a workplace retirement plan, the eligibility for full contribution limit is increasing from $66,000 to $68,000. The phase-out limit is increasing from $76,000 to $78,000.
- For married joint filers who are personally covered by a workplace retirement plan, the income limit for full eligibility is increasing from $105,000 to $109,000. The phase-out limit is increasing from $125,000 to $129,000.
- For married joint filers whose spouse is covered by is a workplace retirement plan even though you aren’t, the income limit for full eligibility is increasing to $204,000, up from $189,000. The phase out limit is increasing from $198,000 to $208,000.
Income limits for Roth IRA in 2022 will change as follows:
- Income eligibility for single tax filers and heads-of-household is increasing to $129,000 from $125,000. The phase-out limit will also be increasing—from $140,000 to $144,000.
- Income eligibility for joint filers will increase to $204,000 for full contributions. This is up from $198,000. Additionally, the phase-out limit is increasing from $208,000 to $214,000.
by Pete McAllister | Accounting News, News, Retirement Savings
No matter the reason for leaving a company, you need to decide what to do with your employer-sponsored retirement plan within 60 days of leaving. If you miss this deadline, you risk the plan being automatically distributed to you or moved to another retirement account. You have several options for your 401(k) plan, and we’ll go over them below.
Keep the Money Where It Is
First, your company should be clear about whether you can keep the funds where they currently are—in your former employer’s plan. Some employers approve this if you have at least a $5,000 balance. You might choose this option simply because you are familiar with the investment options, or because the fees are lower than your new employer’s plan.
Choose a Plan-to-Plan Rollover Option
Many employers offer a plan-to-plan rollover into their 401(k) or other qualified retirement plans. This move doesn’t acquire any tax consequences or penalties. As long as you like the investment options in the new plan, this rollover option can be an obvious choice to keep your savings momentum.
Keep in mind that if you move the money as a withdrawal from the old plan and deposit it to a new plan, rather than choosing the rollover option, your employer may withhold 20% of the sum for taxes. It is your responsibility to report this amount on your taxes for the year the distribution was made.
Roll the Money Over Into an IRA
A direct rollover into an IRA does not incur tax consequences or penalties, and there is an abundance of investment options to choose from—including stocks, bonds, mutual funds, and ETFs. If you typically move jobs intermittently, moving the money into a rollover IRA might be a good option. This way all of your 401(k)s and retirement plans can have one home.
One drawback to this option is that you will no longer be making automatic contributions, so that might curb your savings drive. However, rollover IRAs are commonly flexible, so moving your assets into a future employer’s plan might be an option.
Use the Money
Using the money for personal expenses is an option by taking a lump-sum distribution, but it will cost you. You will owe income taxes on it, and for workers under age 59 ½, you will likely pay a further 10% penalty. Depending on your tax bracket and state and local taxes, you could lose a significant amount of your retirement stash.
Employer Distribution
If your 401(k) balance is less than $1,000, your employer could release the funds via a lump-sum distribution, whether or not you requested it. If this happens and you are within 60 days of terminating your old plan, immediately roll the money into a new employer’s plan or a rollover IRA.
If your balance is more than $1,000 but less than $5,000, your plan administrator is required to move the funds into an IRA unless you specifically request another type of distribution.
In general, according to the Internal Revenue Service (IRS), if your savings is less than $5,000, your employer is permitted to distribute the funds from the plan without your authorization. You should be able to claim on your tax return any taxes or penalties your previous employer triggered when the distribution was made, but it might help to discuss this situation with a tax professional before you file.